Avoid financial penalties, update your disclosure document now

Inside Franchise Business: take action to update your disclosure documentIt’s time! Franchisors, don’t forget to update your disclosure document for the financial year ending 30 June 2017. You could face financial penalties if you miss the deadline or provide inaccurate or misleading information.

The Franchising Code of Conduct requires franchisors to update their disclosure documents within four months of the end of their financial year and for most, this will mean their disclosure documents must be updated by 31 October 2017.

With the introduction of penalties and infringement notices under the Code in 2015, and the ACCC now actively exercising its powers to impose infringement notices and to seek civil penalties in the Federal Court for breaches of the Code, it is more important than ever to ensure compliance.

Increasing importance of a current disclosure document

The ACCC has audit and investigative powers and can issue infringement notices of $9,000 for a corporation.

But that’s small change in comparison to the penalties of up to $63,000 that can be ordered by the Federal Court for non-compliance with the Code. Earlier this year the ACCC issued two infringement notices (totalling $18,000) to Domino’s Pizza Enterprises Ltd for failures by the pizza business to provide franchisees with an annual marketing fund financial statement and an auditor’s report within the allowed time limit under the Code.

The ACCC has also issued Federal Court proceedings against Ultra Tune Australia Pty Ltd and Geowash Pty Ltd alleging Code breaches.

To avoid a penalty for non-compliance franchisors need to:

  • create a compliant disclosure document (clause 8(1));
  • update their disclosure document within four months after the end of each financial year (clause 8(6));
  • give each prospective franchisee a copy of the Code, the disclosure document and the franchise agreement in executable form at least 14 days before the prospective franchisee enters into a franchise agreement or makes a non-refundable payment in connection with the proposed franchise agreement (clause 9(1));
  • give an existing franchisee a copy of the Code, the disclosure document and the franchise agreement in executable form at least 14 days before renewal or extension of the franchise agreement (clause 9(2));
  • within four months after the end of the last financial year, prepare a statement showing the receipts and expenses of any marketing or other co-operative fund for the last financial year and provide a copy of the statement to each franchisee of the network within 30 days of its preparation (clause 15(1)); and
  • within four months after the end of the financial year, have the statement of receipts and expenses of the marketing fund or the co-operative fund audited by a registered company auditor and provide a copy of the auditor’s report to each franchisee of the network within 30 days of its preparation (clause 15(4)).

Disclosure document updates

Many of the changes required for the annual update will be factual, so you can do a lot of the disclosure document updates yourself, such as the following:

  • details of any litigation (Item 4);
  • details of the number of existing franchisees and franchised businesses, including their addresses, telephone numbers and year each franchisee commenced operation (Items 6.1 to 6.3);
  • details of the following key events for each of the last three completed financial years (2015, 2016 and 2017) (Item 6.4):
    • Franchises transferred;
    • Franchised businesses that ceased operating;
    • Franchise agreements that either the franchisor or franchisee terminated;
    • Franchise agreements that were not extended (as defined in the Code);
    • Franchised businesses that the franchisor bought back;
    • Franchise agreements that ended when the franchisor acquired the franchised business.
  • the name, location and contact details for franchisees involved in any of the above key events, unless the franchisees have specifically asked that their details remain undisclosed (Item 6.5);
  • changes to your intellectual property (Item 8);
  • payments (Item 14), including payments to third parties (Item 14.7).
  • marketing or other co-operative fund expenditure for the 2017 financial year (Item 15.1(g));
  • details of any unilateral variations made to existing franchise agreements in the last three financial years (Item 17); and
  • details of whether, in the last three financial years, you have considered any significant capital expenditure undertaken by franchisees in deciding what arrangements will apply at the end of a franchise agreement (Item 18.2).

While you can make all these changes yourself it is recommended you get your lawyer to check they meet the Code requirements.

When lawyers can help

The following sections of the disclosure document involve legal rather than factual updates. Review these sections and if your policies and practices have changed, advise your lawyer to make the necessary amendments:

  • Items 9 and 13 (franchise sites or territories);
  • Item 10 (supply of goods and services to franchisees);
  • Item 11 (franchisee’s supply of goods or services);
  • Item 12 (supply of goods or services – online sales);
  • Item 16 (financing);
  • Item 18 (arrangements to apply at the end of the franchise agreement).

Don’t overlook Item 20. If you provide earnings information or intend to do so, your lawyer needs to update this to avoid exposure to claims by franchisees of misleading or deceptive conduct and misrepresentation.

Your lawyer should also conduct trademark and company searches of the franchisor and its related entities to ensure the information in the disclosure document about trademarks and the associates and officers of the franchisor is correct.

Statements and audits

You need to include in your disclosure document a solvency statement signed by at least one franchisor director, and either the franchisor’s financial reports for the last two financial years or an independent audit report prepared by a registered company auditor for the 2017 financial year.

If you operate a marketing fund or other co-operative fund, before 31 October you must also prepare a statement that shows the fund’s receipts and expenses for the 2017 financial year. Each of your franchisees must be sent a copy of the statement within 30 days of its preparation.

And the statement must be audited before 31 October, unless 75 per cent of your Australian franchisees who contribute to the fund vote to agree that an audit is not required. Please note that the vote must be held before 30 September 2017 and by virtue of the Code, the vote must be conducted annually.

If your franchisees vote that your fund does not need an audit, there is no requirement to obtain an audit report this financial year.

Update your disclosure document annually

Franchisors should treat as an absolute minimum the formal requirement in the Code that franchisors update their disclosure document annually within four months of the end of their financial year.

Before a disclosure document is handed out to a prospective franchisee, you should review it to ensure that it is still up to date and does not give a franchisee a false impression about the franchisor or the system.

For example, a disclosure document created on 31 October 2016 might say there have been no franchise terminations in the past three financial years but over the next 12 months a large number of franchisees may have had their agreements terminated.

Although it might be factually correct that there were no franchise terminations in the past three financial years, the failure to disclose a high percentage of franchisees exiting the network after 31 October 2016 would give a prospective franchisee the wrong impression and be potentially misleading and deceptive, exposing the franchisor to claims by the franchisee.

It is, therefore, critical that franchisors regularly check the contents of their disclosure document.